Facing the Age Wave and Economic Policy: Fixing Public Pension Systems with Health Care in the Wings

1. Facing the Age Wave and Economic Policy: Fixing Public Pension Systems with Health Care in the Wings David A. Wise The BA Festival of Science Pension Reform and the Welfare of Pensioners Exeter, 6-7 September 2004

2. Two overriding economic problems facing aging societies • Financing of social security programs • Paying for health care

3. Cause of Public Pension problem • Under pay-as-you-go social systems governments have over-promised.  • Made promises that cannot be kept.  • Financial commitments made in the past are not sustainable.

4. Cause of health care cost increases • Arises largely because of advances in medical technology. 

5. Problems for the young • Primarily problems for the current young, not the current old. • Problems mean that the young will have to save more than would otherwise be possible. • The young need to spend more on health care than their parents now spend, and save for their own retirement and at the same time pay for the retirement of current retirees.

6. Guiding principle • In my view, in adopting policies to address these problems, the guiding principle should be this: while repairing the financial imbalances caused by social security over-promises, and while preparing for greater health care expenditures that better medical technology will “require,” what policies minimize the cost to the young?

7. Comment on the health care problem and then concentrate on the public pension problem

8. Increasing cost at given age • More older persons means more care, but the bulk of cost increases come from greater expenditure over time for persons of the same age.  • In the United States, health care costs for persons of a given age—70, or 75, or 80--are growing rapidly. • The increase in cost at a given age is the most important reason for cost increases.

9. Technology costs more • Will improve health care in the future.  • Like computers that do more per dollar of cost, medical care will also do more per dollar of cost.  • Even persons spending their own money would be willing to allocate more to health care because they get more for their money. 

10. But unlike computers individuals don’t pay their own money for a given episode of health care.  • Care is paid for through public or private insurance.  • Even countries who limit health care expenditures through restrictions on supply, will, I believe, face increasing pressure to provide more care at higher cost.

11. The key issue • Thus the key issue, I believe, is not population aging or longevity, but how to prepare for spending more on health care.

12. “Good” and “bad” money • Government programs need to provide health care • But policies must also be designed to control cost • “Good money” is money that people would spend on health care even if they were spending their own money—because, like computers, a dollar for health care buys more than it used to.

13. But advanced technology is likely to be used more than it should be. • When people buy computers they are paying with their own money and they won’t pay unless what the computer does for them is worth the cost of the computer. • But this is not typically true for health care.

14. Most health care provided on a “first-dollar” basis. • When care is provided, the cost to the recipient is zero. • A person will accept the care as long as it does more good than harm—it is worth more than zero. • Unlike computers, the worth of the care to the recipient does not have to be worth the actual cost of the care. • Thus a lot of “bad money” can be spent on health care.

15. Medical systems, unlike the market for computers, don’t have good ways to provide care “efficiently.”

16. A test for the success of future health care systems is this: • How does the system accommodate better technology, the increased demand for health care because it is better than it used to be? • What reimbursement rules encourage high-tech procedures when they are effective and discourage their use when they are not? • Or, what changes in health care system provisions would create a more “efficient” system?

17. The Challenge • To the extent this can be done, health care systems will be successful in addressing one of the most important social issues that will face most countries.

18. II. Social Security (Public Pensions) • Motivation: insolvent social security systems • Under pay-as-you-go systems governments around the world have made promises they can’t keep • Systems are not sustainable

19. Belgium Arnaud Dellis, Raphaël Desmet, Alain Jousten, Sergio Perelman, Pierre Pestieau, Jean-Philippe Stijns Canada Michael Baker, Jonathan Gruber, and Kevin Milligan Denmark Paul Bingley, Nabanita Datta Gupta, and Peder J. Pedersen France Didier Blanchet, Ronan Mahieu, Louis-Paul Pelé, Emmanuelle Walraet Germany Axel Börsch-Supan, Simone Kohnz, Giovanni Mastrobuoni, Reinhold Schnabel Italy Agar Brugiavini, Franco Peracchi Japan Takashi Oshio, Akiko Sato Oishi, Naohiro Yashiro Netherlands Arie Kapteyn, Klaas de Vos Spain Michele Boldrin, Sergi Jiménez-Martín, Franco Peracchi Sweden Mårten Palme, Ingemar Svensson United Kingdom Richard Blundell, Carl Emmerson, Paul Johnson, Costas Meghir, Sarah Smith United States Courtney Coile, Peter Diamond, and Jonathan Gruber

20. Reform discussion in almost all countries • Fundamental reform, often calling for funding through personal accounts • Incremental reform calling for changes in the existing pay-as-you-go systems

21. Why not sustainable? • Population aging • Persons living longer

23. Why not sustainable? • Older workers are retiring younger • Over the past 30 years, life expectancy at birth in the US has increased from 71 to 77 • And disability is declining • Yet the most common age of retirement has decreased from 65 to 62 • Retiring at age 62, the typical retiree faces 20 years of living and consuming

26. Why not sustainable? • Social security provisions themselves induce departure from the labor force • Further increasing the ratio of retirees to labor force participants who pay for benefits • Magnifies the financial pressure caused by population aging and longevity

27. Results from International comparison—12 countries • Will discuss three findings • The magnitude of retirement incentive and relation to LFP • The effect of plan provision changes on LFP • The fiscal implications of provision changes • Results pertain to any reform that maintains a defined benefit component

28. Magnitude of incentive effects to retire and LFP • “Unused” labor force capacity • Key plan provisions that matter • Measuring incentives to retire • Incentives and “unused” labor force capacity

32. Key provisions that matter • Age of first eligibility • 53 to 62 across countries • Benefit accrual if delay retirement after 1st eligibility age • Disability (and unemployment) programs in many countries provide early retirement benefits before social security ERA

35. Benefit accrual and measuring incentive to retire • Consider SSW(a+1) – SSW(a) • Assume should be positive • Very often negative • No “actuarial adjustment”is main reason • e.g. Germany ERA benefit at 60, or DI benefit at 57, same as NRA benefit at 65

36. Implicit tax on work • Compensation from working: • Wage earnings • Increase in future retirement benefits • [Decline in PV of benefits if work another year] / [Net earnings if work another year]

43. Effect of changing plan provisions on LFP • Based on micro estimation in each country • Results shown by simulating effect of illustrative policy changes

44. LFP implications of reform • 3 yr increment in eligibility ages • Effect on OLF% of men 56 to 65 • Effect on OLF% of men “25% age + 4 yrs” Common reform: NRA=65, ERA=60, actuarial adjustment, 60% replacement

46. Fiscal implication of reform • Effect on government butget = [Reduction in benefit payments]- [increase in tax revenues] • 3-yr increment in eligibility ages • Actuarial adjustment • Common reform

47. German example: actuarial reform